Angels urge Ottawa to address funding gap for early stage companies

By Debbie Lawes

"Punitive" tax rules and a dearth of early stage investment capital are making it difficult for many tech start-ups to recruit top talent and grow into sustainable companies. The National Angel Capital Organization (NACO) has been taking that message to senior bureaucrats and politicians as part of a lobbying campaign — the largest to date for the 14-year-old group — aimed at growing Canada's funding ecosystem.

NACO is calling for two broad policy changes in the next federal budget: one that incents angels to increase the supply of investment capital; and one that eliminates the so-called "deemed benefit" tax related to founders' shares or employee stock options.

"Angels need to do more deals and recycle their capital faster. But Angels often become illiquid because they have to wait for failure to recycle that capital … what is needed are incentives that will allow Angel investors to deploy more capital at the time they make their investments," NACO states in a white paper released in August.

To ensure a steady flow of capital, NACO recommends the creation of a 15% National Investment Tax Credit, modelled on British Columbia's Venture Capital Tax credit. BC provides angels with a 30% refundable tax credit made on investments in "eligible small business". A 2010 Evaluation of the Venture Capital Program by the BC government found the tax credit returned $2 in provincial tax revenue for every dollar of tax credit.

The idea of an angel tax credit is supported by other industry groups, including the Canadian Advanced Technology Alliance (R$, Nov. 2/15), the Waterloo-based Communitech accelerator and a 2015 survey of 700 business leaders from across Canada (R$, May 14/15). In the US, employees are taxed when they sell their shares.

"We could see that (BC) program becoming national or it could be a single national program or a combination of provincial and national support," says Mike Volker, chair of NACO's policy committee and author of the white paper.

If the government doesn't find business tax credits politically palatable, NACO says angels could instead be allowed to claim accelerated investment write-offs, which would produce comparable benefits.

Another recommendation is the creation of angel co-investment funds, similar to ones set up for venture capital, notably the $400-million Venture Capital Action Plan and the Business Development Bank of Canada's $100-million VC fund.

"These programs are proving effective but they target later stage companies and that's only a small percentage of the companies that need financing. Angel investors not only provide the capital but also their time and expertise to mentor these young companies," says Volker.

NACO is also wading into the politically charged issue of stock options, which have become highly divisive in the public debate over soaring executive pays. NACO argues, however, that start-ups rely on stock options and founders' shares to recruit experienced managers in lieu of high salaries. Volker describes the current tax rules as "punitive" as founders' shares are taxed as income as soon as they are received and not as capital gains when they are sold or cashed in. He says the rules were designed to target employees working with large corporations, not start-ups.

"The employee is taxed right away even though they've received no financial benefits, so it becomes a disincentive rather than an incentive to attract these kinds of people," he contends. "That means angel investors and venture capitalists have to put more money into companies to attract top talent."

The recommendation could find a sympathetic ear with the current federal government. In March, the Liberals abandoned a campaign pledge to increase the effective tax rate on stock option gains after tech industry leaders argued such a move would threaten the government's commitment to build Canada's innovation sector. Finance minister Bill Morneau has said the option is no longer being considered.

NACO is working with its members to prepare a more detailed submission in response to the government's consultations on Canada's Innovation Agenda.

R$